Earnings Call Transcript - LX Q3 2023

Operator, Operator

Good day and thank you for standing by. Welcome to LexinFintech's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. It is now my pleasure to hand you over to the IR Director, Ms. Mandy Dong. Please go ahead, ma'am.

Mandy Dong, IR Director

Thank you, Amber. Hello, everyone. Welcome to Lexin's third quarter 2023 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today are our CEO, Jay Xiao; President, Jared Wu; and CFO, James Zheng. Before we get started, I'd like to remind you of our safe harbor statement in our earnings press release, which also applies to this call. During the call, we may refer to business outlook and forward-looking statements, which are based on our current plans, estimates, and projections. The actual results may differ materially, and we undertake no obligation to update any forward-looking statements. Last, unless otherwise stated, all figures mentioned are in RMB. Jay will first provide an update on our overall performance. James will cover the financial results in more detail. And lastly, Jared will then discuss risk management. I will now turn the call over to Jay. His remarks will be in Chinese and the English translation will follow.

Jay Xiao, CEO

Hello, everyone. It's a pleasure to share with you our performance for the third quarter of 2023. In the face of the current industry-wide and macroeconomic challenges, we adopted our prudent and steady strategy in the third quarter despite a slight volatility in asset quality. We reasonably tightened our risk strategy to balance growth and quality. In the third quarter, we adhered to the dual-wheel drive of risk and data, pushed forward the refinement of operations, and continued to strengthen our fundamental capabilities, recording another solid growth performance. Transaction volume was RMB 63.3 billion, up 13% year-over-year. Loan balance under management was RMB 120.7 billion, up 28% year-over-year. Revenue was RMB 3.5 billion, up 30.4% year-over-year. Net profit was RMB 371 million, up 34.4% year-over-year. In the third quarter, the effectiveness of both new customer acquisition and existing customer operation was further improved. The synergies between e-commerce and the consumer credit business were further enhanced, and the tech empowerment business continued to grow with its commercialization capability being validated, and we are accelerating its expansion. There were three main highlights of the third quarter results. Firstly, refined operations have led to improved efficiency in both acquiring new customers and managing existing ones. In terms of new customers, we made a major upgrade on our new customer acquisition model and strategy in the third quarter, resulting in notable achievements. The efficiency of attracting customers through feed channels increased by 38.5% compared to the first quarter. The approval rate, number of drawdown borrowers, and facilitated loan volume for new customers all showed improvement of over 20% compared to the control group. Additionally, early-stage delinquency indicators decreased by nearly 20%. We expect both the scale and quality of new customers to continue to benefit in the fourth quarter. In the third quarter, we further enhanced our offline customer acquisition capabilities. This included upgrading the organizational structure of the offline inclusive finance team, improving the sales management system, strengthening the cultivation of standardized talent, and enhancing the ability to accurately identify offline customers. These efforts solidified the advantages of our offline direct customer acquisition model, resulting in a decrease in overall customer acquisition cost. Sales expenses in the third quarter declined by 9.5% compared to the second quarter. We see more potential and opportunities for offline growth in the future, and we'll continue to deepen our presence in this unique business model. In terms of existing users, we maintained a steady operation and strengthened the underlying capability building for model application, further enhancing our service capabilities. During the quarter, we introduced more data sources and built an identification system centered around the credit system of PBOC. We improved the model framework for the entire customer acquisition, risk management, and operational life cycle. The sequencing and stability of the model were improved by 10% to 20% over the previous version. In the third quarter, we utilized the enterprise WeChat for user operations, which has accumulated 700,000 borrowers and improved service efficiency and satisfaction. Through refined operations targeting high-quality customer groups by our enterprise WeChat compared to traditional methods, we achieved a nearly 65% increase in customer order rates and a 107% increase in transaction volume. In the third quarter, our product, Lexin card, priced below 18%, targeted towards high-quality customer segments, delivered satisfying progress. After using those incurred, users' willingness to place orders and the transaction volume has been significantly improved. The order rate, average transaction volume per person, and total transaction volume all experienced around an 80% increase. This effectively enhanced the engagement of high-quality active borrowers and facilitated the return of more high-quality settled users, expanding the scope and opportunities for managing our premium user base. The second highlight was the continued growth of Lexin ecosystem and further enhancement of synergies. Firstly, the tech empowerment business, after achieving quarterly profit in the fourth quarter of last year, grew further with a 59% sequential increase in the third quarter. After nearly two years of exploration, we have completed upgrades in solutions, diversified our product portfolio, and validated the standardized capabilities in systems and deliverables, which was well recognized by multiple urban and rural commercial banks. The 59% growth rate further validated the commercialization capability of our tech empowerment business, although it currently accounts for a small proportion of Lexin's overall business. In the context of increasingly refined industry regulation and the downward trend in consumer credit market interest rates, the tech empowerment business can help banks quickly undergo retail credit digitalization transformation with tremendous market potential. It can also bring better synergy to funding cooperation and drive deeper and broader collaborations between Lexin and the financial institutions. Currently, the tech empowerment business team is accelerating its expansion and will cover more city and rural commercial banks to further expand the scale. Secondly, our e-commerce business brought out more value in terms of customer new acquisition and activating existing ones, further enhancing the synergies with our core consumer credit business. In the third quarter, our e-commerce division continued to solidify its highest level authorization for Apple T1s and Huawei L1s, maintaining an advantage in scale and initial supply. This further boosted consumer spending on our e-commerce platform, taking Huawei as an example; sales of the new Mate 60 Series and the X5 reached a record high for the year in the third quarter with an approximately 60% increase in revenue compared to last year's Mate 50 product. In addition to our strength in the consumer electronics 3C category, we introduced more high-quality new brands and merchants onto our platform in the third quarter, covering categories that are favored by the younger generation, such as luxury goods, sports, and packed goods. The number of new merchants reached 241, representing a sequential growth of 51% in brand coverage. With the addition of more merchants and expansion of product categories, a large number of existing users have been activated, leading to a stimulation between e-commerce and consumer credit business. During the 11/11 shopping festival, the period from November 1 to 11, the growth in the e-commerce consumer base resulted in a notable increase in transaction volume from high-quality active customers with a sequential increase of approximately 12.4%. At the same time, these active consumer credit users further drove e-commerce spending, creating a reinforcing cycle within our business ecosystem. The third highlight is the data-driven approach to improve quality and efficiency, further enhancing our profitability. In the third quarter, we implemented a series of data-driven measures to improve our operational efficiency. These measures included applying data tools such as life-like models to strengthen procedural operations, enhancing the efficiency of funds and asset matching through a decision simulation system, and improving the customer retention rate for settled users. The drop in funding cost has further improved profitability. In the third quarter, the company achieved significant optimization of our funding structure and entered into a strategic partnership with multiple major banks, including nationwide joint-stock banks. Funding costs reached a new record low, with a 21 basis point drop on a quarter-on-quarter basis. The rapid development of our business also relies on continuous investment in technology and research and development. In the third quarter, our company invested RMB 127 million in research and development, maintaining our industry-leading position. During the quarter, we accelerated the development of the use case of AI large language models in our business through exclusive data pretraining and fine-tuning of business data. In terms of business application, we have already fully implemented the AI model in key business processes, such as telemarketing, customer service, and loan collection. In terms of working tools, the AI model is widely applied in scenarios such as coding assistant tools, generating design ideas, and data analysis, enhancing the overall operational efficiency of the company. In terms of risk management, we are closely watching industry trends and actively exploring the use case of AI large language models. These initiatives have significantly improved the overall operational efficiency and the customer experience. Solid technology advantages in the third quarter, Lexin has been selected for the fourth time as one of the top 500 Chinese service companies, making us the only fintech company on the list for the fourth time. In terms of corporate social responsibility, in the third quarter, we made major upgrades to our consumer rights protection measures. Upon the foundation of our 5S Guardian system, we have carried out four major initiatives: one, strengthening our data security management system; two, enhancing anti-fraud protection capabilities; three, expanding intelligent customer service applications; and fourth, intensifying efforts to combat illegal anti-collection groups. These measures collectively established a comprehensive safety firewall for consumers. From January to August this year, Lexin intercepted 160 million instances of data security attacks, maintaining a record of zero data leaks since the launch of the data protection and governance system. The anti-fraud system has prevented potential user losses of over RMB 270 million. And customer satisfaction has reached 99.6%. Looking ahead to the fourth quarter, in the face of a complex and uncertain external environment, we will adhere to the principle of prudent operation and prioritize risk management. We will continue to enhance risk management capabilities and improve asset quality while striking a fine balance between transaction volume and asset quality. We maintain the guidance on full year loan origination we gave earlier this year, ranging from RMB 245 billion to RMB 255 billion, representing a 20% to 25% year-over-year growth.

James Zheng, CFO

Thank you, Jay. I will now provide more details on our financial results. Please note that all numbers are in RMB, unless otherwise stated. In the face of a sluggish macroeconomic environment and subdued consumer confidence, we have sustained our growth for the sixth straight quarter, signaling a robust V-shaped recovery since the first quarter of 2022. Our focus on improving risk management capabilities, customer upgrading, operational refinement, cost optimization initiatives, and optimizing our funding, particularly by lowering the early repayment rate, has prepared us for this quarter. Amidst the ongoing economic uncertainties, our strategy has been prudent. We have moderated new loan originations to prioritize asset quality and conservatively made ample provisions in our financials, which while impacting us in the near term, supports our long-term financial health. To provide some context, first, let's take a look at the year-over-year number of comparisons. Total loan origination increased by 12.7% year-over-year to RMB 63.3 billion. Revenue climbed to RMB 3.5 billion, up 30.4% year-over-year, largely due to reduced early repayments and larger outstanding loan balance, now at RMB 121 billion. Notably, we significantly cut the early repayment ratio in Q3 to a level at about 90% of Q2's level and aim to keep it optimal in Q4. The average weighted APR remained under 24%, with loans below this threshold comprising 86% of total loans, up over 5% from last year. Our funding cost hit a record low of 6.4%, down from 7.0% last year, attributable in part to successful partnerships with the national banks, which we anticipate will further reduce costs. Loan tenors decreased as we fine-tuned our portfolio's structure in response to market uncertainty, averaging 13.1 months compared to 13.8 in Q3 of 2022. Cost efficiencies continue with operating expenses, including processing and services, sales and marketing, R&D, and G&A falling to 0.91% of the average loan balance, a 35 basis point saving from the previous year. Consequently, net income rose to RMB 371 million, a 34.4% increase year-over-year, improving our net margin to 10.6%. Despite the heightened provisions, the increase underscores our resilient profitability and business momentum. Apart from the above year-over-year analysis, I would also like to share some perspectives from quarter-over-quarter comparisons. Total GMV remained relatively stable as we balanced maintaining asset quality with business growth. A slight take rate improvement reflects effective early repayment control and reduced funding costs, although offset by pricing reductions, shorter loan durations, and additional provisioning. Risk management remains a cornerstone strategy, yet factors like the slow economic recovery and challenges within the loan collection industry have slightly affected asset quality as reflected in metrics such as day one delinquency rate, M1 collection rate, and 90 days delinquency rate. For instance, our 90 days delinquency rate in Q3 was 2.67%, which is slightly higher in comparison with 2.59% in Q2. Nonetheless, we have adjusted our bad debt provisions, reaching a coverage ratio of approximately 350%, which is defined as a total provision amount divided by the principal amount of 90 days delinquent loans. The current fluctuation in asset quality across the industry seems to continue to cloud Q4. We are vigilant and have taken all measures to safeguard our asset quality level. Operating expenses fell by 7.2% from the last quarter, primarily from reduced sales and marketing and general administrative spending. With the increased provisions from Q2, we still achieved a 4.2% sequential growth in net income and maintained a 10.6% net margin. From both year-over-year and quarter-over-quarter perspectives, we have made significant improvement during Q3. Although macro headwinds persist, we have maintained the rebounding pace of our business and anticipate the business growth momentum to continue. Let's review some specific financial items. Total operating revenue hit RMB 3.5 billion for Q3 with an increase of 14.8% quarter-over-quarter and 13.4% year-over-year, driven mainly by the credit facilitation business, which saw a significant increase both quarterly and annually. Tech empowerment services also grew, while installment e-commerce platform service revenue declined due to the high Q2 numbers, driven by the 618 promotion and an accounting reclassification. Despite the orders, the e-commerce GMV grew by 12.8% year-over-year. The expense ratio demonstrates our continued progress in cost optimization, notably in marketing, where we have achieved greater efficiency and lower customer acquisition costs. The sales and marketing expenses decreased by 9.4% quarter-over-quarter and decreased by 3.3% year-over-year, which was mainly due to the improved efficiency of upgraded RTA customer acquisition models. In Q3, new users with approved credit lines increased 15.1% and new active users increased 8.2% on a quarter-over-quarter basis, indicating a lower customer acquisition cost in Q3. Net profit for the quarter was approximately RMB 371 million, marking a steady increase with a 4.2% growth quarter-over-quarter and a 34.4% growth year-over-year. Our cash position is strong, ending the quarter with around RMB 5 billion in hand and a solid equity position of RMB 9.8 billion. In Q3, we have declared a recurring cash dividend plan and paid out a cash dividend for the first half of 2023 amounting around USD 90 million, equivalent to roughly 20% of the total net profit for the first half of 2023. Looking forward, we will continue to look for ways to return more value to shareholders. Looking ahead to the rest of 2023. Given the current macros and the pressure on asset quality throughout the industry, we remain conservative in loan origination pacing. We maintained the earlier guidance of annual GMV of RMB 245 billion to RMB 255 billion growth, which represents a 20% to 25% year-over-year. These estimates reflect our current expectations, which are subject to change. To sum up, Q3 marks our sixth consecutive growth quarter. Our key strategies — risk management, customer enhancement, operational refinement, and cost efficiency — are all paying off. As we navigate ongoing macro and industry challenges, we will maintain our focus on asset control, measured business expansion, and operational optimization, poised to seize opportunities as they arise.

Jared Wu, President

Thank you, James. In the third quarter, we continued to step up our efforts in honing our holistic risk management system and optimizing our customer base on the ground of our corporate strategy, risk management upgrading, and customer base upgrading, which have yielded consistent results. Although we continued to improve our risk management capabilities, our loan collection rate experienced some fluctuations due to the slow recovery of macro conditions and the rise of illegal anti-collection activities recently. We anticipate this impact from these factors may last into Q4; therefore, we have built a more prudent risk management approach going forward. Meanwhile, we rolled out a series of countermeasures to mitigate these impacts on loan collection. For instance, in the collection process, we set up our internal collection workforce and leveraged the advantage of internal collection manpower, and we also increased the proportion of manual case handling to uphold the collection right. During the third quarter, through continuous optimization of our RTA model and the risk models for new customer credit line approval, we achieved a 50% improvement in customer acquisition efficiency and a 20% reduction in new customer risk levels. In Q4, we will gradually amplify our experimental flow and continue to rapidly advance strategy iteration, striving to accumulate a sufficient number of high-quality customers this year and lay a solid foundation for next year's growth. In the third quarter, we accelerated the recruitment of top-notch industry talent in the risk management space to further enhance our core competitiveness. We anticipate their professional skills and extensive experience in the risk management space will assist us in achieving more breakthroughs. Adhering to the risk management-driven principle, we will continue to build up our industry-leading risk management team. Looking ahead, in the face of the current macroeconomic situation in Q4, we will continue to adhere to the principle of risk management first, adopt a prudent strategy, and at the same time, continue to enhance our underlying risk management capabilities, and persistently integrate the overall level of our risk management.

Mandy Dong, IR Director

Operator, that closed all our prepared management remarks. I think we are now good to open the floor for questions.

Operator, Operator

Our first question comes from Alex Ye from UBS.

Alex Ye, Analyst

I have two questions. The first one is regarding the management remarks about the control in early repayment ratio in Q3, which helped to increase the revenue take rate. Could you share with some more color in terms of the specific measures taken and provide us with some color into your expectation for Q4? And the second question is about your new customer acquisition. We have noticed good progress in Q3 in terms of both lower customer acquisition costs and a number of new customers acquired. So could you also give more color on this?

Jay Xiao, CEO

Thank you, Alex. So in the first quarter, we set up a special task force directed by the company's management level and then spanning multiple departments such as operations, to determine based on customers' outstanding balance for credit line approval strategies based on their own performances to better determine whether they are likely to make repayments, avoid early repayment processes, or not to better avoid our strategic error that could cause losses. We also issued the suitable coupons to deter early repayments, which effectively helped us to reduce the early repayment rate and optimize our revenue take rate level. Our task team held weekly meetings to review, adjust, and re-optimize strategies, achieving a very good result in the third quarter. In this quarter, our early repayment rate was only about 9%, a significant improvement compared to the second quarter, leading to a noticeable increase in our revenue take rate. We expect to maintain this strategy and optimized level in the fourth quarter. In the third quarter, we continued to iterate our ability to acquire new customers and achieve the same reduction in the new customer risk in comparison with the previous quarter. We conducted a significant upgrade of our new customer risk model, including integrating more sophisticated measures, and promoting the RTA model upgrade through our key media channels. Specifically, our customer acquisition efficiency will increase by 50% and new customer risk will be reduced by 20%. Purely from an earnings perspective, sales and marketing expenses decreased by 4% quarter-over-quarter, while newly registered users increased by 9.0% quarter-over-quarter. New users with improved credit lines increased by 15.1% and new active users increased by 8.2% on a quarter-over-quarter basis, all indicating a much lower customer acquisition cost in the third quarter. In the fourth quarter, we will increase the volume of our comparison and experimental group mentioned before to continue pushing forward the strategy at a faster pace and reserve a significant number of high-quality customers as well as include pushing the new model, which has been showing prominent results to better lay a foundation for next year's growth. Hope that answers your questions, Alex.

Operator, Operator

Our next question comes from the line of Yada Li from CICC.

Yada Li, Analyst

I will do the translation. I was wondering if you could elaborate more about how the current loan demand looks like in October and November? And compared with the previous quarter, how is the recent trend of the asset quality? And that's all.

Jay Xiao, CEO

Okay. Thank you, Yada. At the operational level, we see that the demand growth in October and November so far is down slightly compared to the third quarter, and no significant recovery is seen. Specifically, demand levels were slightly weaker in October compared to the third quarter, likely ranging in the mid-single digits. The average daily demand in November up to now, benefiting from the boost of the 11/11 e-commerce specials, seems to be flattish compared to the third quarter. However, considering the seasonality factors, including the banks' yearly slight tightening and the recent trend of overall capital flow shifting to government and real estate assets, we maintain a cautious and conservative stance on fourth quarter volumes. In terms of asset quality, as Jared mentioned earlier, in the fourth quarter, the factors affecting our asset quality persisted mainly because the macro economy is still in a period of steady recovery, as well as the growth of the anti-collection industry is expected. This could pressure our collection rate to a certain extent. We are currently facing challenges regarding asset quality, and various indicators have become concerning. However, we are actively taking various countermeasures to deal with the fluctuations caused by external factors, such as increasing the proportion of our own inbound cases and continuously iterating our risk management model. The volatility of risk will certainly impose some pressure on our growth for the fourth quarter, but we are implementing measures to combat that. Hope that answers your question, Yada. Just to add one last point regarding the results and progress we're seeing for new customer acquisitions, they are showing promising signs. The volume resulting from new customers, along with lower customer acquisition costs, and improved risk levels looks very encouraging and should be a positive factor for us moving forward.

Operator, Operator

Our next question comes from the line of Betty Li from CLSA.

Betty Li, Analyst

I will translate by myself. The first one, given the current loan guidance, I think the Company is on track in maintaining the full year loan origination. But I just wonder if you have any outlook for the 2024 loan demand. The second one is I just wonder if the Company has any further share buyback plans.

James Zheng, CFO

Okay. I will take the question. Basically, the first question is related to the outlook, and the second question is about the buyback, right? Basically, from a macro perspective, we still believe there is a considerable amount of uncertainty in the fourth quarter. The overall recovery of consumption still remains relatively slow. At the same time, due to typical seasonal factors, funding supply in the fourth quarter is a little bit tight, so we expect the overall lending volume in Q4 to be broadly in line with Q3. On the other hand, we also have other factors affecting seasonal asset quality. These continue to exist as mentioned earlier, such as the macroeconomic environment still being slightly slow and the impact of combating illicit financial activities related to debt collection affecting our rates and asset collection overall. Given this, asset quality remains under slight pressure at this point, and short-term risk indicators show some fluctuations. As it stands, we will continue to maintain a prudent approach for Q4, prioritizing risk management and safety. Thus far, we have maintained a good growth rate, completing about RMB 188 billion for the first three quarters of this year, which is about a 26.7% year-over-year growth. We are confident in our ability to achieve the RMB 245 billion to RMB 255 billion GMV growth target, representing a 20% to 25% growth rate. Regarding 2024, we will likely wait until the end of this year to provide further guidance, hoping for more certainty in the macros next year. Regarding any buyback plans, the Board approved two buyback plans last year, completing about RMB 50 million early this year. The Board authorized a RMB 20 million buyback in November last year. We haven't done anything recently on that front. However, last quarter we declared a dividend plan, committing to a payout of 15% to 30% of our net income as dividends. For the first half of this year, we paid out 20% of our net income, completing the payout last month. We will continue to evaluate ways to return value to shareholders, and at the end of this year, we will reassess our dividend plan for the second half.

Operator, Operator

We have reached the end of the question-and-answer session. I'll now turn the conference back to the Company for any additional closing comments.

Mandy Dong, IR Director

Well, I think that closes our conference call today. Thank you again, everyone, for joining us today. If you have further questions, please contact us via our contact information on the IR website. Thank you all. Have a good day and a good night. Thank you.

James Zheng, CFO

Thank you. Okay. Bye-bye.

Operator, Operator

Thank you. That concludes today's conference call. Thank you for participating. You may now disconnect.